BUS 156

1. BUS 156 Chapter 1 The Investment Environment

2. What is an Investment? • Investment: any venue that provides an increase in value, and where funds can be placed with the expectation that it will generate positive income and/or that its value will be preserved or increased • Return: the reward for owning an investment • Current income • Increase in value

3. Types of Investments • Securities or Property • Securities: stocks, bonds, options • Real Property: land, buildings • Tangible Personal Property: gold, artwork, antiques • Direct or Indirect • Direct:investor directly acquires a claim • Indirect: investor owns an interest in a professionally managed collection of securities or properties

4. Types of Investments • Debt, Equity or Derivative Securities • Debt:investor lends funds in exchange for interest income and repayment of loan in future (bonds) • Equity: represents ongoing ownership in a business or property (common stocks) • Derivative Securities: neither debt nor equity; derive value from an underlying asset (options) • Low Risk or High Risk • Risk: chance that actual investment returns will differ from those expected

5. Types of Investments • Short-Term or Long-Term • Short-Term:mature within one year • Long-Term:maturities of longer than a year • Domestic or Foreign • Domestic:U.S.- based companies • Foreign: foreign-based companies

6. Suppliers and Demanders of Funds • Government • Federal, state and local projects & operations • Typically net demanders of funds • Business • Investments in production of goods and services • Typically net demanders of funds • Individuals • Some need for loans (house, auto) • Typically net suppliers of funds

7. The Investment Process

8. Types of Investors • Individual Investors • Invest for personal financial goals (retirement, house) • Institutional Investors • Paid to manage other people’s money • Trade large volumes of securities • Include: banks, life insurance companies, mutual funds and pension funds

9. Steps in Investing • Step 1: Meeting Investment Prerequisites • Adequately provide for necessities of life, including funds for meeting emergency cash needs • Adequate protection against losses from death, illness and disability • Step 2: Establishing Investment Goals Examples include: • Accumulating retirement funds • Enhancing current income • Saving for major expenditures • Sheltering income from taxes

10. Steps in Investing • Step 3: Adopting an Investment Plan • Develop a written investment plan • Specify target date and risk tolerance for each goal • Step 4: Evaluating Investment Means • Assess potential return and risk • Chapter 4 will cover risk in detail • Step 5: Selecting Suitable Investments • Research and gather information on specific investments • Make investment selections

11. Steps in Investing • Step 6: Constructing a Diversified Portfolio • Use portfolio comprised of different investments • Diversification can increase returns or decrease risks (Chapter 5 will cover diversification in detail) • Step 7: Managing the Portfolio • Compare actual behavior with expected performance • Take corrective action when needed

12. Taxes in Investing Decisions • “It’s not what you make, it’s what you keep that is important.” • Tax Planning Involves: • The desired return after-taxes • Type of income received from investments • Timing of profit-taking and loss recognition

13. Taxes in Investing Decisions • Basic Sources of Taxes in Investing • Federal: tax rates from 10% to 35% • State taxes • Types of Income for Individuals • Active Income: income from working (wages, salaries, pensions) • Portfolio Income: income from investments (interest, dividends, capital gains) • Passive Income: income from special investments (rents from real estate, royalties, limited partnerships)

14. Taxes in Investing Decisions • Ordinary Income • Active, portfolio and passive income included • Taxed at progressive tax rates (rates go up as income goes up) • Capital Gains and Losses • Capital Asset: property owned and used by taxpayer, including securities and personal residence • Capital Gain: amount by which the proceeds from the sale of a capital asset are more than its original purchase price • Capital Loss: amount by which the proceeds from the sale of a capital asset are less than its original purchase price

15. Tax Rates and Income Brackets for Individual and Joint Returns (2006)

16. Taxes in Investing Decisions • Taxation of Capital Gains • Capital assets held less than one year: ordinary income tax rates • Capital assets held more than one year: 15% (or 5 %) • Taxation of Capital Losses • Capital losses can be used to offset capital gains • Up to $3,000 per year of capital losses can be used to offset ordinary income (such as wages)

17. Tax-Advantaged RetirementPlans • Allows taxes to be deferred until withdrawn in future • Employer-sponsored plans • Profit-sharing plans, thrift and savings plans, and 401(k) plans • Self-employed individual plans • Keogh plans and SEP-IRAs • Individual plans • Individual retirement arrangements (IRAs) and Roth IRAs

18. Investing Decisions Over Investor Life Cycle • Investors tend to follow different investment philosophies as they move through different stages of the life cycle. • Youth Stage • Twenties and thirties • Growth-oriented investments • Higher potential growth; Higher potential risk • Stress capital gains over current income • What are some examples of age-appropriate investments? • Common stocks, options or futures

19. Investing Decisions Over Investor Life Cycle • Middle-Aged Consolidation Stage • Ages 45 to 60 • Family demands & responsibilities become important (education expenses, retirement savings) • Move toward less risky investments to preserve capital • Transition to higher-quality securities with lower risk • What are some examples of age-appropriate investments? • Low-risk growth and income stocks, preferred stocks, convertible stocks, high-grade bonds

20. Investing Decisions Over Investor Life Cycle • Retirement Stage • Ages 60 and older • Preservation of capital becomes primary goal • Highly conservative investment portfolio • Current income needed to supplement retirement income • What are some examples of age-appropriate investments? • Low-risk income stocks and mutual funds, government bonds, quality corporate bonds, bank certificates of deposit

21. Investing in Different Economic Environments • Market Timing: process of identifying the current state of the economy/market and assessing the likelihood of its continuing on its present course • Three Conditions of the U.S. Economy • Recovery or expansion • Corporate profits are up, which helps stock prices • Growth-oriented and speculative stocks do well • Decline or recession • Values and returns on common stocks tend to fall • Change in the general direction of the economy’s movement

22. Investing Decisions and Interest Rates • Interest rates are the single most important variable in determining returns to investors for bonds and fixed-income securities. • Interest rates and bond prices move in opposite directions: • When interest rates go up, bond prices go down • When interest rates go down, bond prices go up

23. The Role of Short-Term Means • Liquidity: the ability of an investment to be converted into cash quickly and with little or no loss in value • Primary use is for emergency cash reserve or to save for a specific short-term financial goal

24. The Advantages and Disadvantagesof Short-Term Means • Advantages • High liquidity • Low risks of default • Disadvantages • Low levels of return • Loss of potential purchasing power from inflation

25. Popular Short-Term Investment Means

26. Popular Short-Term Investment Means

27. Popular Short-Term Investment Means

28. Investment Suitability • Short-Term Means are used for: • Savings • Emphasis on safety and security instead of high yield • Investment • Yield is often as important as safety • Used as component of diversified portfolio • Used as temporary outlet waiting for attractive permanent investments